This article first appeared in City & Country, The Edge Malaysia Weekly on November 23, 2020 - November 29, 2020

The impact of the nationwide Movement Control Order (MCO) and its variations since March 18 to contain the spread of Covid-19 is reflected in the country’s poor economic performance in 2Q2020.

“Malaysia’s GDP contracted 17.1% in the quarter (1Q2020: +0.7%) as measures such as travel restrictions, enforced business closures and restricted social activities left many businesses and economic sectors struggling to stay afloat,” says Knight Frank Malaysia executive director of corporate services Teh Young Khean when presenting The Edge/Knight Frank Kuala Lumpur and Selangor Office Monitor 3Q2020.

In the near term, the rental rates and occupancy levels of office buildings in Malaysia, especially in the Klang Valley, will experience further downward pressure as the gap between supply and demand continues to widen amid weaker office demand and a shrinking pool of tenants, opines Teh.

“As health and safety remain a priority, companies are continuing to implement new workplace strategies to reduce the risk of transmission. Rotation schedules, work from home or multi-location offices are becoming commonplace, while a few large corporations have opted to shut their offices completely until 2021. Depending on how these new working arrangements fare, the new strategies may have significant impact on the office market as companies re-evaluate their office footprint,” says Teh.

The current estimated supply of office space in KL city is 55.73 million sq ft, while KL fringe and Selangor have 29.43 million sq ft and 23.87 million sq ft respectively. This brings the total estimated supply to 109.03 million sq ft. Knight Frank Malaysia projects an increase of 11.4% in office space in the next 2½ years.

Teh believes that as organisations start to reconfigure their office space to address both cost saving and departments that could work remotely, there may be an increase in sublet space in the market.

“The current crisis has also compelled many organisations to rethink their standard operating mode while embracing technology such as cloud-based IT solutions and communication channels in their business operations.

“Temporary measures in business continuity plans, such as the aforementioned working from home, split teams and de-densification to adhere to physical distancing requirements, may soon become the new normal and lead to a reversal of the open office trend, with fewer desks, but more areas for collaboration and meeting space as work habits evolve,” says Teh.

Meanwhile, co-working or flexible space, which saw a drop in demand during the MCO period and its aftermath, is expected to grow over the medium to longer term, with large corporations and multinational companies (MNCs) showing interest in flexible/smaller office space that can accommodate temporary or split-team operations at a fixed cost, which includes operating expenses and a short-term lease with low commitment. The small and medium enterprise (SME) segment, however, is expected to continue to struggle and take longer to recover.

“Co-working groups with multiple locations are reviewing their portfolios to identify centres that are non-performing or find avenues for short-term relief, either by seeking rent waivers from landlords or entering into revenue share agreements, before making the ultimate decision to shut down, if possible,” says Teh.

Landlords of both newer and older office buildings are reportedly engaging with key strategic tenants on lease renewals well ahead of their expiry dates for the mutual benefit of both parties.

“Landlords are looking to retain their anchor tenants by offering attractive renewal packages, which include longer rent-free periods, while tenants want to manage their costs and potentially improve their tenancy terms during this period. Potential tenants are also looking at short-term leases amid the unprecedented crisis,” says Teh.

He notes that the RM35 billion Short-Term Economic Recovery Plan (Penjana), which was unveiled on June 5, contains 40 initiatives strategically designed to stimulate growth as the country restarts its economy. To further boost economic recovery, several initiatives and additional assistance were recently announced under the RM10 billion Prihatin Supplementary Initiative Package (Kita Prihatin).

According to Knight Frank Malaysia, the average rental rates of office space (Prime A+ and Grade A) in KL city were lower in 3Q2020 as the prolonged pandemic continued to affect businesses and the economy, although overall occupancy rates remained relatively stable due to committed leases.

“Similarly in KL fringe, the average rental rates of Grade A offices in the sub-localities were also under pressure while the overall occupancy rate remained flattish,” says Teh.

In KL city, the average rental rates of new CBD Prime A+, new CBD Grade A and old CBD Grade A offices dipped 1.1% to RM10.65 psf, 2.6% to RM6.38 psf and 0.8% to RM5.31 psf quarter on quarter (q-o-q) respectively.

Grade A offices in KL fringe are facing a similar situation, with average rental rates in Damansara Heights down 0.4% to RM5.52 psf; KL Sentral down 0.1% to RM7.14 psf; Taman Tun Dr Ismail (TTDI)/Mont’Kiara/Dutamas down 0.6% to RM5.36 psf; Mid Valley City (MVC)/KL Eco City (KLEC) down 1% to RM6.08 psf and Pantai/Bangsar down 0.5% to RM5.84 psf. The rate in Bangsar South/Kerinchi remained unchanged at RM5.57 psf q-o-q.

Over in Selangor, the average rental rates in Petaling Jaya, Subang Jaya and Cyberjaya dipped to RM4.51 psf (2Q: RM4.54 psf), RM4.32 psf (2Q: RM4.34 psf) and RM3.99 psf (2Q: RM4.09 psf) q-o-q respectively. Shah Alam’s average rental rates were flattish, up marginally from RM3.48 psf to RM3.49 psf. Overall, average rental rates dipped to RM4.26 psf from RM4.31 psf in the previous quarter.

As for the average occupancy rates, KL city remained unchanged q-o-q at 69.4%, with new CBD and old CBD registering the same rates q-o-q at 69% and 71.9% respectively.

In KL fringe, Damansara Heights, TTDI/Mont’Kiara/Dutamas and Pantai/Bangsar saw no changes in their average occupancy rates, standing at 77.9%, 83.6% and 82.5% respectively. MVC/KLEC and Bangsar South/Kerinchi saw increases of 1% to 73.1% and 0.3% to 91.2% respectively.

Only KL Sentral registered a drop in average occupancy rate, down 1.2% to 95%, due to tenant movements from Plaza Sentral and Nu Tower 2. The overall average occupancy rate in KL fringe was down 0.1% q-o-q to 86%.

The overall average occupancy rate in Selangor was up marginally from 78.1% in 2Q2020 to 78.8% in 3Q2020. The occupancy rate in Petaling Jaya was up 1.6% to 80%, while that for Subang Jaya, Shah Alam and Cyberjaya were marginally lower at 81.2% (2Q: 81.6%), 78.5% (2Q: 78.7%) and 75.4% (2Q: 75.6%) respectively.

Meanwhile, KL registered a negative net absorption of 39,299 sq ft in 3Q2020 as landlords struggled to maintain their occupancy rates amid the pandemic. Selangor fared better with a net absorption of 111,092 sq ft in the quarter under review. According to Teh, this is due to positive tenant movements to the newly completed 1 Powerhouse in Bandar Utama.

“Concerns over cash flow have businesses reviewing or postponing real estate decisions to refrain from non-essential capital expenditure. The current entry restrictions from selected countries have also caused delays in decision-making for MNCs planning to set up or expand their presence in Malaysia,” says Teh.

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